Every activity has its own language, and forex is no different. In forex, “pips” are largely how you measure success in trading. Many traders start out by learning some basic trading concepts, a trading formula, get all worked up over finding a good broker, and fuss over fundamentals. And, while all these are part of learning about how to trade forex, they all take a backseat to pips.
What Are Pips?
A pip is a percentage point and the standard term that’s often used to describe the smallest price fluctuation possible in a currency, relative to other currencies. Pips are sometimes confused with “points” or “ticks.”
If you see a quote for a currency pair, like the EUR/USD, for example, the pip is the change in the fourth decimal point of the quote. You’ll often see quotes that look like this: $1.8574. A move of 5 pips would be $1.8579. In other words, the value of 1 pip is equal to 1/100 of one cent. That’s a small amount of money, which is why almost every forex trader leverages their capital account and makes many trades throughout the day.
Most currency trading platforms will give you quotes in real-time, so that you can track pips pretty easily throughout the day. So, when you hear or read about a trader making 100 pips in a day, you know that he’s talking about a one-cent movement (which is actually quite a large move).
What’s A Pip Worth?
While a pip is worth only 1/100th of a penny, forex is traded in lot sizes of $100,000. Even small lots of $10,000 can make a lot of money for traders. Even a small upward move of 5 pips translates into $50 if you buy 5 lots.
So, the money that’s made is made “in bulk.” In other words, it’s not the gross profit percentage that matters, it’s the size of the lots (amount of money involved) that matters.
Pips and Spreads
The spread is the difference between your buying and selling price. It’s how brokers make money on trades, since they typically do not charge commissions. When you exit a trade, you won’t get all of your money back. Instead, you’ll get the total pip gain less the spread.
So, if you entered a EUR/USD pair at 1.4567 and exited at 1.4577, you moved up 10 pips, but you may only receive 1.4575 – the broker took 2 pips from you. This is his commission: 2 pips.
This is why it’s important to pay attention to spreads when working with a broker, as they can dramatically affect your net profit at the end of the day.
Pipettes are like a pip’s little brother – a really little brother. The pipette is the smallest price movement for fractional pips. You don’t see this often, and many brokers don’t even bother quoting them. However, it’s important to at least take note of them just in case you run into an extra decimal place out there in the wild.
Samuel Watkins likes to help new traders by sharing his know-how on Forex trading. An avid writer, he enjoys researching how to be successful in the Forex market. Look for his informative posts on a variety of blogs and websites on the web today.